Canada: Evolving Law: An Update On The Regulation Of ICOs And Cryptocurrencies

On August 31, 2017, the authors published
an article A Brave New World: Regulation of Initial Coin
Offerings describing the rise of initial coin offerings (ICOs) and
their regulation by Canadian and US regulatory authorities. In that
article, the authors wrote about the Decentralized Autonomous
Organization (DAO) ICO that sold DAO tokens to create a pool of
assets to fund "projects" that DAO token holders voted to
fund. The DAO is a prominent ICO as a hacker used a flaw in the
DAO's code to divert and steal approximately US$50 million of
the funds raised. On July 25, 2017, the United States Securities
Exchange Commission (the SEC)1 published an
investigative report on the DAO, focused on the threshold question
of whether the tokens it offered constituted a
"security." The SEC broke ground by concluding that DAO
tokens were securities and released its report as a warning to the
industry: in certain circumstances, the offer of coins/tokens
through ICOs may be caught by securities laws and participants
should do their due diligence and govern themselves accordingly.
Further, the Canadian Securities Administrators (the CSA) issued a
Staff Notice2 on cryptocurrency offerings which is in
line with the cautionary statements made by the SEC and encouraged
all businesses offering coins/tokens through ICOs to carefully
determine whether a security is involved and to consider seeking
legal and other professional advice in making this
determination.

Since that article, we have seen further reactions from
regulators around the world, while Canadian regulators apply
securities laws to ICOs for the first time.

Regulators Around The World Weigh In

China

China has played a key part in the ICO boom, housing one of the
world's most active cryptocurrency communities by trading
volume. On September 4, 2017, The People's Bank of China (PBoC)
shook up the industry by announcing a ban on ICOs and an immediate
halt on all ongoing ICO activity. PBoC further required all
proceeds already raised by way of ICOs be refunded to investors. It
has also been reported that PBoC plans to inspect domestic
exchanges and consider banning these exchanges from trading
cryptocurrencies.

Despite taking these drastic measures, the director general of
PBoC's research institute has continued to promote the wide
range applications for blockchain technology. He emphasized that
although PBoC has banned ICOs, this should not prevent companies
from continuing their research into blockchain technology through
avenues other than ICOs.

Following China's ban on ICOs, Hong Kong's Securities
and Futures Commission followed the lead of the SEC and the CSA by
cautioning the market that certain coins or tokens may be
securities and subject to regulation.

South Korea

South Korea has set up a digital currency task force group (the
Task Force) to determine regulations for cryptocurrencies, and in
particular, bitcoin. The Task Force is made up of key players such
as the Bank of Korea and the Financial Services Commission. At the
end of September 2017, the South Korean Financial Services
Commission announced it is prohibiting domestic companies from
participating in ICOs and prohibiting the trading of virtual
currencies.

Europe

The Gibraltar Financial Services Commission is implementing a
regulatory framework in January 2018 to oversee the cryptocurrency
exchange industry. In the mean time, the Gibraltar Financial
Services Commission is cautioning the market much like the
regulatory bodies in Hong Kong, the US and Canada.

On September 29, 2017, the Swiss Financial Market Supervisory
Authority (FINMA) provided guidance on ICOs and announced it was
examining a number of ICOs to determine whether they violate
anti-money laundering or securities laws. Additionally, FINMA's
guidance suggested enforcement proceedings may be initiated where
such legislation has been circumvented or breached.

Canadian Developments

Despite the cautionary guidance provided by securities
regulators in Canada and around the world, the number of ICOs and
the amount of money being invested in coins/ tokens continues to
grow and regulators continue to react.

Playing Nice in the CSA Regulatory Sandbox

In our earlier article, we noted that the CSA has set up a
"regulatory sandbox" (the Sandbox) to allow firms to
register and/or obtain exemptive relief from securities laws
requirements through a swift and flexible process. Two companies
have already taken advantage of this approach:

1. Impak Finance Inc. (Impak): Québec's financial
regulatory and oversight body, the Autorité des marches
financiers (AMF), granted Impak exemptive relief from the dealer
registration and prospectus requirements in connection with its
proposed ICO of a new digital currency, known as MPK. Utilizing
this token, consumers with a preference for socially-focused
merchants can purchase goods and services over a platform.

The relief granted by the AMF was subject to conditions. The AMF
granted the registration relief on the conditions that Impak: (i)
conducts know your client (KYC) and suitability reviews for each
investor; (ii) verifies that each investor that represents itself
as an accredited investor actually is an accredited investor; (iii)
does not provide investment advice to the investors; (iv) deals
fairly, honestly and in good faith with its investors; and (v)
establishes policies and procedures to manage the risks associated
with its business. The prospectus relief was granted on the
condition that the first trade in MPK be made between an Impak user
and an impact organization

(which are required to undergo a screening process to join the
Impak ecosystem). The AMF also imposed ongoing continuous
disclosure requirements.

2. First Block Capital Inc. (First Block): On September 6, 2017,
the British Columbia Securities Commission granted First Block
Capital Inc. registration as an investment manager to operate a
bitcoin investment fund. This represents the first registration of
a cryptocurrency fund in Canada that provides Canadian investors
with access to bitcoin investments through a regulated entity. The
Commission imposed a number of conditions on First Block's
registration relating to the risks inherent in investing in
cryptocurrencies. Among other things, First Block must provide the
Commission with reporting on its operations and on its oversight of
the custodians and brokers it uses in distributing its fund.

Continued Uncertainty

Despite these cooperative examples between provincial securities
regulators and industry, the regulatory regime remains uncertain.
For example, this fall, a Canadian company named Kik offered an ICO
for its Kin tokens. This cryptocurrency is billed as an extension
to Kik's existing messaging app product with 300 million
registered users, allowing creators, innovators and subject matter
experts to easily monetize their content. Two days prior to the
token sale, which has raised approximately $120 million to that
date, Canadian investors who had already been subjected to a KYC
screening, received an email indicating that they could not
participate in the sale. Lack of direction from the Ontario
Securities Commission was cited.

Enforcement Issues

Entities offering ICOs are not the only ones struggling to adapt
in this new environment. Enforcement of these virtual enterprises
is also challenging regulators, as seen by the example of PlexCoin.
PlexCoin offers a new cryptocurrency that purports to allow people
to undertake their everyday transactions privately anywhere in the
world. It encouraged investors to take advantage of its discounted
pre-sale, citing a potential 1,354% return on investment.
PlexCoin's website claimed to have raised US$2.5 million during
its week long pre-sale. However, before the pre-sale closed, the
AMF successfully applied for orders from Québec's
Financial Markets Administrative Tribunal (FMAT) to compel PlexCoin
and related entities to (i) cease soliciting investors, (ii) take
down their internet ads, and (iii) post the FMAT Order on the
PlexCoin websites. It also ordered Facebook to close PlexCoin's
accounts.

To date, while plexcoin.com is offline, a new website bearing
the URL plexcoin.tech has emerged, and PlexCoin's facebook
account appears active.

Conclusion

These developments underscore the constantly shifting ground on
which this new industry operates. Securities regulators around the
world continue to be cautious, as they shape regulations for ICOs.
In Canada, regulators are applying securities laws to regulate this
industry for the first time, drawing that fine line between
protecting investors and encouraging innovation. While there have
been positive developments that reflect a willingness of regulators
to work with this new industry and facilitate ICOs and the
development of cryptocurrency funds, the regulatory environment is
far from clear.

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